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ECB raises rates, helps Portugal

Jul 07 2011 15:29 Reuters

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Frankfurt - The European Central Bank (ECB) raised interest rates for the second time this year on Thursday and signalled further policy tightening to come to tackle inflation, despite the eurozone’s intensifying debt crisis.

But it offered help to hard-pressed Portugal after rating agency Moody’s downgraded its debt to junk status this week, committing to keep providing it with liquidity.

“We will continue to monitor very closely all developments with respect to upside risks to price stability,” Trichet told a news conference after the bank raised interest rates by 25 basis points to 1.5%.

Economists said before the news conference that use of that phrase would signal a further rate rise in 2011, likely to be in the last three months of the year.

Eurozone inflation held at 2.7% in June, well above the ECB’s target of just under 2%. Trichet said monetary policy remained accommodative even after Thursday’s increase.

The rise in the ECB’s benchmark interest rate to 1.5% was widely expected after the bank’s recent reiterations that it was in “strong vigilance” mode - code traditionally used to signal a hike.

“No surprise at all,” Berenberg economist Holger Schmieding said of Thursday’s quarter-point rise.

The ECB raised its subsidiary overnight deposit and borrowing rates in unison, opting not to re-widen its so-called rate corridor this time around.

Recent eurozone data has generally disappointed. The latest industrial orders rose less than expected, while growth in the bloc’s dominant service sector has also slowed sharply.   

A Reuters poll found economists have softened their rate hike view as the eurozone debt crisis has escalated over the last month.

The ECB’s key rate is expected to rise just once more this year, to 1.75%, with only two quarter-point increases forecast to follow for all of next year.

In contrast, the Bank of England kept rates on hold on Thursday.

Helping hand to Portugal

The downgrading of recently bailed-out Portugal’s credit rating to junk rattled financial markets on Wednesday and cast new doubt on European efforts to rescue distressed eurozone states without debt restructuring.

The ECB has pledged to keep liquidity flowing to eurozone banks that need it, and Trichet said Portuguese debt would be accepted by the ECB as collateral for now, come what may.

“We have decided to suspend the application of the minimum credit rating threshold... for the purpose of Eurosystem credit operations in the case of marketable debt instruments issued or guaranteed by the Portuguese government,” he said.

“This suspension will be maintained until further notice.”

The ECB has proved a major stumbling block in agreeing a second rescue plan for Greece, as it has threatened to refuse restructured Greek bonds as collateral in its lending operations in the event of a default or a “restricted default”, which rating agencies are threatening to impose.

“We say no to selective default,” Trichet said.

Refusing to accept Greek bonds as collateral would deprive Greek banks of the funds on which they rely, crippling the Greek economy and risking contagion to other eurozone economies. Most economists expect the ECB to baulk at that and keep banks afloat somehow.    
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